I've got a deal for you

How do we value businesses?

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The normal parameters are book value + rate of growth in expected future earnings + Market price of fixed assets/investments owned by the company not directly used by the business (net of liabilities) + other assets like Goodwill, brand value etc. In that context, it will be very difficult to arrive at a valuation for Facebook. It has no significant cash earnings, still burning cash in millions, no net fixed assets, but has enormous brand recall and could be of great strategic potential to a Google or Microsoft.

So what’s left? Price offered by the first few bidders? At this moment, it looks like exactly two, or maybe four, parties have determined that number, and they're all in business together -- the Facebook board; Microsoft, which says that its $240 million investment got it 1.6 percent of the company; and reportedly two unnamed hedge funds that each put in about the same amount as Microsoft for the same percentage. It's the financial equivalent of Humpty Dumpty's take on language: "When I use a word, it means just what I choose it to mean, neither more nor less."

Nick Carr calls BS, and rightly so. "First, the investment is part of a broader deal, the details of which are unknown," he writes. "Clearly, Facebook needs cash to support its growth, and the cash payment was a price Microsoft had to pay to nail down the partnership. It has to be seen in that light, not as a market-cap marker. Second, and more important, Microsoft's investment is not financial but strategic. The company is currently engaged in a multi-front competitive battle under conditions of great uncertainty. Facebook forms one of the fronts, and partnering with the company is far more about gaining future strategic options and blocking the advance of a competitor (Google) than about making a financial gain through the appreciation of Facebook stock."

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That gives it a universal appeal. Hey, I’ve got a deal for you. I need one person to send me $10 in exchange for a 0.000001 percent interest in Sequel Ventures, my sole proprietorship business, a closely held consulting outfit that helps businesses needing PE / VC / Debt funding and helping brokerages secure wealthy Foreign Investor client relationships. Voila -- we are partners in a $1 billion company….

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Tempting Zuckerberg

So it's not really a shocker to hear that Microsoft, lacking a foothold in the social scene, is considering a substantial investment in Facebook, which has designs on becoming something like a Web operating system. What has raised some eyebrows -- and some red flags -- are the numbers being bandied about. According to the Wall Street Journal, Microsoft is talking about taking a 5 percent stake in Facebook at a price between $300 million and $500 million, which, on the top end, would value the social site at a whopping $10 billion. And should Google pursue its own rumored interest in a piece of the Facebook action, the bidding could push that valuation up by $5 billion more.

Will Mark Zuckerberg, (official founder of Facebook) be able to hold back this time…?

That kind of money buys a lot, not all of it good. Facebook offers growth, a flexible platform, continuing innovation (a beta IM client is coming Friday), and a whole lot of the page inventory and sticky users that advertisers crave. But it also brings a running dispute over its creation, privacy concerns, and, as of yesterday, an investigation by the New York Attorney General's office into whether the site does enough to protect users against sexual predators.

So are those big numbers totally out of line? Apparently not, if you broaden the definition of value. There's a lot of strategic value beyond the pure financial value in an investment like this. There's not a lot of a zero-sum games, but there's only one home page. There's only one thing that is the first thing you see. ... That's what I think is the strategic value, and I think Microsoft needs it more than Google" - as Jeremy Lew of Light Speed Venture partners says.

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I am not too sure about that. May be I am from the old school. I still believe bidding frenzy should never outdo valuation math.

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